Yardeni Research | The Fed’s Economic Forecast Versus The Consensus & Ours

Executive Summary:

Investors clearly fear a recession is coming—that’s what the recent stock market correction suggests. The consensus of economists probably puts the prospect of a recession at 35% (as we now do). Fed officials likely expect to avert a recession by lowering interest rates; FOMC meeting participants dropped their GDP projections last week to 1.7% this year. As for us, we see a fork in the road. One way leads to stagflation, which includes the possibility of a recession (35% odds). But our base case remains the Roaring 2020s (65%), in which a tech-led productivity boom lifts profit margins, propels GDP, suppresses inflation, and fuels wage growth and consumers’ buying power. … Check out the accompanying chart collection.

Forecasts I: The Consensus.

Trump Turmoil 2.0 has caused a correction in the stock market. The S&P 500 fell 10.1% from its record high on February 19 through March 13. ▌View Related Live Charts: MM US Stock Fundamental Index

It was down 7.8% on Friday from its peak. The Nasdaq is down 11.8% from its peak on December 16 through Friday’s close. ▌View Related Live Charts: US - NASDAQ Composite

The Magnificent-7 stocks led the recent rout. The Roundhill Magnificent Seven ETF (MAGS) is down 18.8% from its record high on December 17, while the Defiance Large Cap ex-Mag 7 ETF is down 6.0% since February 19. ▌View Related Live Charts: US - Magnificent Seven Total Market Cap and Share of S&P 500

The latter is essentially the S&P 500 minus the Mag-7, i.e., the “S&P 493.”

As we’ve previously noted, S&P 500 corrections (10%-20% declines) typically occur when investors fear a recession is imminent. The decline is attributable to a drop in the forward P/E of the S&P 500. The forward earnings of the index continues to rise because industry analysts tend not to share the recession concerns of investors. That’s because such fears don’t plug well into the analysts’ earnings models; the analysts are more attuned to what managements are saying about the companies they cover. Bear markets (declines of 20% or more) occur when investors’ recession fears are realized, forcing industry analysts to scramble to cut their earnings estimates.

So the forward P/E is a leading indicator of the economy that isn’t very accurate, while forward earnings is highly correlated with the Index of Coincident Economic Indicators, which is the most accurate monthly indicator of the business cycle. ▌View Related Live Charts: US Leading Economic Index (LEI) - Coincident Economic Index (CEI) vs ISM PMI

Currently, investors fear a recession, while forward earnings continues to rise to record-high territory. On March 5, Debbie, Eric, and I raised our subjective probability of a recession from 20% to 35% because of the Trump administration’s increasing tariff turmoil and shotgun approach to reducing federal government payrolls.

Polymarket.com, an online betting platform, showed that the odds of a recession stood at 22% in mid-February. ▌View Related Live Charts: MM Global Recession Probability

It rose to about 40% during the first half of March and is now at 35%. Polymarket also allows traders to place a bet on “How high will inflation get in 2025?” However, the choices are limited to inflation rising above 3%, above 4%, and up to “above 10%.” The latest betting shows 48% odds on inflation rising above 3%.

Meanwhile, the March Consumer Sentiment Index (CSI) survey showed that respondents expect a median inflation rate of 4.9% over the next 12 months, while a similar February survey conducted by the Federal Reserve Bank of New York showed 3.1% over the same period. ▌View Related Live Charts: US - UMich Inflation Expectations

It’s hard to pin down a precise consensus outlook for inflation. The same can be said about an outlook for the economy. That’s partly because consensus forecasts change over time. Also, the consensus of the general public is bound to be different than that of economists, which is bound to differ from investors’ consensus. Different strokes for different folks, depending on their personal experiences and biases. Indeed, the CSI survey has become very partisan lately, with Democrats much more pessimistic than Republicans about the outlook for inflation and the economy.

The Wall Street Journal conducts a quarterly survey of economists. The latest survey was covered in a January 19 article. Here are the salient points:

(1) GDP & recession odds. The odds of a recession over the next 12 months in the January poll was down to 22%, the lowest since January 2022 and down from the most recent peak of 63% during October 2022. The economists collectively forecast that real GDP will increase 2.0% in 2025.

If we may be allowed to forecast the forecasters, we reckon that the survey in early April will show that their subjective odds of a recession has increased to 35%, the same as ours. We guess that their 2.0% real GDP forecast for this year will remain unchanged. Ours remains unchanged at 2.5%-3.0%.

(2) Inflation. Economists had already begun modeling the effects of President Trump’s plans to raise tariffs, cut taxes, and restrict immigration at the time of the article: “The upshot: Inflation and interest rates are likely to be higher for at least the next two years than forecasters anticipated before the election.”

The consensus of 73 economists showed the CPI inflation rate at 2.7% y/y through December 2025, up from 2.3% in the October survey. Their forecast for inflation this year is likely to be closer to 3.0% in the April survey on concerns that Trump’s tariffs are bound to boost prices at least on a one-shot basis. In late November, Trump said he would impose tariffs of 25% on Mexico and Canada and 10% on China on day one of his presidency. He started talking about more widespread “reciprocal tariffs” about a month ago. They are scheduled to be announced on April 2, which is likely to influence the next WSJ survey results.

(3) Interest rates. Here is what the WSJ article reported about the consensus outlook for interest rates: “Faced with stickier inflation, economists expect the Fed to keep interest rates higher through 2027 than previously forecast. The midpoint of the range of the federal funds rate [FFR], currently 4.375%, is now seen ending the year at 3.89%, up from the October average projection of 3.3%. Economists now expect the 10-year Treasury bond yield to end 2025 at 4.4%, up from an October projection of 3.7%.”

We reckon the consensus FFR forecast will remain about the same, calling for two 25bps cuts this year. The year-end bond yield forecast might drop a bit from the WSJ survey’s 4.4% to the current level of 4.2%.

We are still in the none-and-done camp on Fed rate cutting this year. If we are wrong, the current consensus of economists and the FFR futures market—two rate cuts—will likely be right. ▌View Related Live Charts: US - Federal Funds Rate vs. S&P 500

We still expect the 10-year Treasury bond yield to range mostly between 4.25% and 4.75% this year.

Forecasts II: The Fed.

The latest Summary of Economic Projections (SEP), released by the Federal Open Market Committee (FOMC) after its meeting last Wednesday, showed that the meeting participants collectively expect to lower the FFR from 4.25%-4.50% currently. In terms of their new economic forecasts, their “dot plot” continues to have two 25bps cuts this year, two next year, and one in 2027, with the “longer-run” FFR still seen at 3%. ▌View Related Live Charts: US - FedWatch Interest Rate Projections

The latter implies that the current level of the FFR is restrictive.

Presumably, most FOMC participants are anticipating that they will have to lower the FFR closer to its longer-run level to avert a recession. Indeed, they lowered their real GDP growth forecasts to 1.7% from 2.1% for 2025, to 1.8% from 2.0% for 2026, and to 1.8% from 1.9% for 2027. This likely reflects the growth drags from government spending cuts and the prospect of significant tariffs squeezing profit margins and household spending power.

That’s a relatively pessimistic forecast considering that the labor force is growing between 0.5% and 1.0% y/y currently and productivity is growing around 2.0% y/y. ▌View Related Live Charts: US - Real Labor Productivity for All Workers

Those numbers add up to real GDP growth rates of 2.5%-3.0% y/y, consistent with our more upbeat outlook. ▌View Related Live Charts: US - Unit Labor Costs vs. Nonfarm Business Real Hourly Output

In the SEP, the median unemployment rate projection for the end of this year was raised from 4.3% to 4.4%. It remained at 4.3% for the ends of both 2026 and 2027.

So why are Fed officials saying that they are in no hurry to lower interest rates if they are anticipating they will have to do so to avert a recession later this year? Indeed, just a few hours after the FOMC voted to leave the FFR unchanged, in a post Wednesday night on Truth Social, President Trump encouraged Chair Jerome Powell and his colleagues to ease policy as the administration enters the next phase of its aggressive trade policy.

“The Fed would be MUCH better off CUTTING RATES as U.S.Tariffs start to transition (ease!) their way into the economy,” Trump wrote. “Do the right thing. April 2nd is Liberation Day in America!!!”

The Fed is in no hurry to do so because the latest economic indicators suggest that the economy remains resilient. Furthermore, Fed officials have raised their inflation expectations since the December SEP, with core PCED now expected to end the year at 2.8% versus 2.5% in December, presumably reflecting upside pressure on prices from tariffs, but their 2026 forecast remains 2.2%. In other words, the FOMC expects tariffs to have a transitory impact on inflation.

In his press conference on Wednesday, Fed Chair Jerome Powell confirmed all the above:

(1) Transitory uncertainty. Powell mentioned the words “uncertain” or “uncertainty” 16 times. He attributed the abnormal amount of uncertainty to Trump 2.0. For example, he said, “So in the current situation, there’s probably some elevated uncertainty because of … significant policy shifts in those four areas that I mentioned: tariffs, immigration, fiscal policy, and regulatory policy. So there’s probably some additional uncertainty, but that should be passing; we should go through that. And then we’ll be back to the regular amount of uncertainty.”

(2) Tariffs are the known unknown. The main source of uncertainty is clearly tariffs, according to Powell: “We don’t know what’s going to be tariffed. We don’t know for how long or how much [or] what countries. We don’t know about retaliation. We don’t know how it’s going to transmit through the economy to consumers. That really does remain to be seen. [T]here are lots of places where … that price increase from the tariff can show up between the manufacturer and a consumer. Just so many variables. So we’re just going to have to wait and see.”

(3) Inflation closer to target. Powell noted that inflation has moderated significantly over the past two years. He acknowledged that it “remains somewhat elevated relative to our 2 percent longer-run goal.” He also said, “Estimates based on the consumer price index and other data indicate that total PCE prices rose 2.6% over the 12 months ending in December and that, excluding the volatile food and energy categories, core PCE prices rose 2.8%.” He did not mention the recent spike in the CSI survey’s one-year-ahead expected inflation rate. Instead, he said that long-term inflation expectations “remain well anchored.”

It's not clear why Powell estimated December’s PCED inflation rates. January’s numbers came out at the end of last month showing headline and core inflation rates of 2.5% and 2.6%. ▌View Related Live Charts: US - Personal Consumption Expenditure Price Index (PCE)

He might have misspoken and was actually referring to February’s PCED, which will be released on March 28.

February’s headline and core CPI inflation rates were 2.8% and 3.1%. ▌View Related Live Charts: US - Consumer Price Index (CPI) - Core Goods

More encouraging were the 2.0% and 2.2% readings excluding shelter.

The CPI rent of shelter inflation rate remains elevated at 4.3% y/y, but it remains on a moderating trend.

▌View Related Live Charts: US - Consumer Price Index (CPI) - Shelter (YoY)

(4) Transitory tariff inflation. Powell mentioned the word “transitory” twice when he discussed the likely impact of tariffs on inflation. For example: “As I’ve mentioned, it can be the case that it’s appropriate sometimes to look through inflation if it’s going to go away quickly without action by us, if it’s transitory. And that can be the case [with] tariff inflation. I think that would depend on the tariff inflation moving through fairly quickly and critically as well [as] on longer-term inflation expectations being well anchored.”

Describing inflation as “transitory” didn’t work out so well for Powell last time, in 2021, just before inflation turned into a persistent problem during 2022 and 2023. Powell noted that Trump 1.0’s tariffs didn’t move the needle on inflation. But he didn’t mention that the Smoot-Hawley Tariff of June 1930 had an extremely deflationary impact, causing the global economy to fall into a depression.

(5) Good place. On balance, Powell came across as relatively optimistic: “And right now, we feel like we’re in a very good place. Policy’s well positioned. The economy’s in … quite a good place …[W] hat we do expect is to see further progress on inflation, and …as we see that—or if we were to see weakening in the labor market that could foster—we could then be in a position … of making further adjustments. But right now … we don’t see that, and we see things as in a really good place for policy and for the economy. … [S]o we feel like we don’t need to be in a hurry …to make any adjustments.”

Powell did not respond to Trump’s post Wednesday evening.

Forecasts III: Our Two Scenarios.

We’ve decided to fold our 1990s meltup/meltdown scenario into our Roaring 2020s scenario. The current correction in the stock market suggests that the former has played out already, as the bull market’s highflyers have been hit hardest by the current correction. That leaves us with two scenarios: the Roaring 2020s, to which we assign a 65% subjective probability, and a mostly stagflation scenario, with a 35% probability. The former includes the possibility of a rebound in the former highflyers, while the latter includes the possibility of a recession.

So our base case continues to be more upbeat than both the consensus expectations of economists and the projections of Fed officials. In this Roaring 2020s scenario, productivity growth continues to be boosted by technological innovations. That boosts the growth rate of real GDP, keeps a lid on inflation, fuels the growth of real wages (i.e., consumers’ purchasing power), and lifts profit margins.